One of the main benefits of trading via a limited company is that – if things go wrong – directors are not personally liable for the company’s debts, unless they have breached their statutory duties, or carried out negligent or fraudulent acts.
So, what does limited liability mean in practice?
Under UK company law, a limited company is treated as an entirely separate legal entity to its members (i.e. shareholders or guarantors, depending on the type of structure).
Most companies are limited by shares, which means the liability of shareholders is limited to the nominal amount due on unpaid shares (often £1, but may be a different sum). If you have already paid for your shares, then there will be nothing due.
In the case of a company limited by guarantee, the liability of members (guarantors) is limited to a fixed sum (often a nominal £1), as prescribed by the memorandum which would have been drawn up upon formation.
Limited liability applies to LTD companies, PLCs, and LLPs.
What about sole traders (the ‘self employed’)?
If you set up a business as a sole trader, you are your business, and will not benefit from the limited liability afforded to limited company owners. The same applies to partnerships (two or more individuals running a non-registered business).
If you are a sole trader, you can be sued personally if a legal dispute takes place.
What if you’re a director?
As a director, you have certain responsibilities to your company, as enshrined in the Companies Act 2006. These include taking reasonable care and working in the best interests of the company.
Directors should benefit from having limited liability for their actions when acting on behalf of the company, however, if a director is found to have acted negligently, or even criminally, then – unsurprisingly – a court may well determine that he or she should be held liable for such actions. This may also be the case in a corporate manslaughter claim.
There may also be occasions when a director may need to waive his limited liability, for example: if you’re taking out a bank loan or overdraft, or securing any other type of credit on behalf of your company. It is not unusual for creditors to seek personal guarantees from directors in these situations.
An important difference between sole traders and limited company directors
Having limited liability for your company’s debts is an attractive incentive for incorporating. It is unusual (and difficult) for a third party to take legal action against a director when a company has done something wrong (except in the circumstances listed in the previous section).
There are, of course, many other pros and cons to setting up as a sole trader vs. forming limited company, which we discuss here.
In all cases (both if you’re a limited company director, a sole trader, member of a partnership, or LLP), we strongly recommend you take out business insurance to cover you in the event of a claim, however unlikely you consider that to be. Find out more in this article – which types of insurance must you have in place?